Monday, November 20, 2006

Optimism or Cynicism ?!?!


Is the fascination for commercial real estate, infrastructure and other hard assets a cold and calculating appraisal of the prevailing political economy that yields a high-probability scneario for more of the same: low interest rates, continued fiscal expansion, yet more current account, trade deficits & industrial hollowing giving way to further asset-price inflation WITHOUT limited imported-goods-price inflation or an interest-rate or currency accident??

Or is the continued run-up in asset prices simply the so-called savings glut and its attendant late-cycle cascades, in combination with what are currently low real interest rates combined with FX & interest-rate stasis, that is causing the herd (even the smart herd) to perhaps myopically "use it or lose it"??

My own money is [wrongly, to date I must admit] on the latter. Though other historically prescient investors have shyed away from the party (LA's Colony Capital Leucadia's Steinberg, Baupost's Klarman, etc.), today, the ranks are joined by Sam Zell (Equity Office Props), and more recently, David Geffen (who dumped a significant chunk of his art collection). While betting against either Blackstone or Carlyle hasn't, in aggregate, been extraordinarily rewarding, with the frenzy and prices-paid along with assumed leverage accelerating, one would be forgiven for wondering whether this stampede into large-scale leveraged asset acquisition is a bold statement of unbridled optimism or an ultimate statement "to be short paper & long assets" because the end of the BWII regime is nigh. Comments please!


Aaron Krowne said...

Plus you've got all these highly-publicized wrong-way bets on the dollar in 2005 (Rubin and Buffett), despite the fact that the updraft of the dollar in that year was probably caused by the repatriation provision of the Jobs Creation Act of 2004. Wall Street has been all too eager to spin this as a warning not to bet against a strong dollar, and by extension, BWII.

It will end, and probably soon, but when in specific, who knows. All the politicos know that it must, but no one wants to make the first move. This suggests to me it will find it's own impetus to do so.

Anonymous said...

(Moldbug speaking. I'm not trying to be secretive or anything, I am just too lazy to actually register.)

Another way to look at the "short paper, long assets" world is that actors are adopting a rational herd strategy toward political risk.

The political incentive of central banks is that they cannot punish appreciation in assets whose depreciation would "harm the economy" - ie, reduce (often unproductive) activity.

Therefore, it makes sense for rational actors to flock together for maximum safety, by choosing assets whose bubble skin has the strongest political immunity to the Fed's needle.

US residential housing and large-cap stocks, which have the broadest political exposure base, are natural havens. I expect them to remain so.

The other way to escape from the Fed is, of course, gold. This has its own natural economic immunity, but no political immunity at all - far from it.

The choice between the two is, again, political. In a world whose political system has accepted responsibility for managing the economy, finance cannot escape this Clausewitzian note.

Anonymous said...


Japan may be a good place to find out. Why don't you collar some behind the scenes LDP powerbrokers, 80's "real estate investors", and forex managers and see how they view the savings glut/asset drought debate.

Agreed there appear to be a few trends to "hard assets" e.g. property yielding fixed income depending on the terms (dont forget the currency aspect), to taking out assets (private equity) when the going (cost) is good (a bet against lower interest rates hedged by the interest tax shield) and continued investment in the most liquid assets.

Re: the latter is there a trend? Vols? Is there a trend regarding the most liquid to more illiquid, from risk free to more risky vols? prices?

Is there Gresham's law operating with regard to the smartness of money?

"Cassandra" said...

Yes, its been apparent that in walking the ridgeline between the increasingly deep chasms of deflation to one side and inflation on the other, we were always more likely to fall towards the path of least resistence. Even though sober-minded Volcker-ism remains a possibility, it will never get the nod until all other politically expedient means have been exhausted (and we are no where near the combined double-digit "misery index" we saw when I was saw my last laser light show at Red Rocks Amphitheatre.

That said, I had thought Memories of Weimar, and Memories of Japanese Hyperinflation would have provided a more vigorous foil to a more secure tethering of inflationary expectations. But alas, the Japanese really do have a long memory regarding their post WWII humiliation by the American's and remain masters of not yielding anything until they are bloody well forced. Eurozone, too, seems all-too-willing to stomach larger-than-comfort-zone price rises in exchange for a massive and secure security buffer firmly in orbit around the Community, hence Eurozone broad continue to grow in the mid-teens amidst sclerotic real growth. Go figure...italy's black ecomnomy is not THAT large!

The thing is, everyone knows that the hedonic path of least resistence ultimately leads to Schumpetarian destruction, albeit more dislocatingly than would be the case with pre-emption. Roubini will be right, but having just returned from the UK last night, I can tell you their home prices are galloping away again with all the gazumping and fun that preceeded the last washout that saw 40 or 50% percent real destruction in home values. If I were a betting man now, I would reckon that the nominal US home prices surprise the bears in a way that only a cynical Austrian would sardocially appreciate.

Anonymous said...

Add in gaming of Moldbug's Fed and political "puts", a little "too big to fail" and you have a nice brew....
Which will return the most, which permit a quick exit and which will deteriorate the least, if things go awry?

"Double, double, toil and trouble;
Fire, burn; and cauldron, bubble.

Fair is foul, and foul is fair.
Let's fly away through the fog and filthy air.

When shall we three meet again?
In thunder, lightning, or in rain?

Anonymous said...

(Moldbug again)

Agreed on the real estate and the bears. (Though as I own leveraged real estate in San Francisco, I may be a little, um, biased.)

There is no such thing as a real estate "bubble." That is, I totally reject the animal-spirits explanations offered by the Shillers of the world.

What is really going on is that the market is pushing monetary energy, so to speak, into housing. Because dollar interest rates do not even remotely compensate holders of dollar securities for the level of dilution that is going on these days, people are very sensibly using housing as a medium of saving.

Housing is nonfungible and cannot be a true replacement currency, like gold. Transaction overhead is immense. However, unlike gold, it is directly useful to its owner (ie, not all of its value is exchange value).

The main problem with housing as a pseudocurrency, though, is that it is not hard. That is, it is easy - with some kinds of housing, in some places - to create new housing.

Housing is a true bubble, for example, in parts of Vegas and Florida. Anywhere its price is dominated by production cost rather than scarcity, housing is a lousy place to put your money. Fortunately, neither San Francisco nor Tokyo is in this class.

The Fed can certainly try to scare the housing pseudocurrency. They can intervene against it much as they do against gold. However, because they are politically sensitive and already seem to be in the process of starting a recession, the housing downside in scarcity-dominated markets is, I think, relatively small compared to that of markets which have less of a political base - even US equities.

And certainly, of course, gold. Owning gold is like owning a house in a scary neighborhood. It could be the next Williamsburg. It could be the next Bronx...

Anonymous said...

It is far easier to create credit for housing than to build one.

Housing has been a source of "spot" dissaving and (to date) "futures" saving.

My guess is that housing and equity markets have the same political base but in the meantime risk and cost have been diffused.

Cassandra said...


I would not be so quick to dismiss "the bubble" thesis, if only to hone in on a more precise definition. Speculative animal spirits are at work, hence the confident equity extraction highlighted by anonymous.

I believe there are differing investors here with differing levels of information and motivation: buyers (particularly buy-to-let investors), and their obsessional mind-numbing chatter about "worth" and "gains" and extrapolating them forward in buying yet another property with yet more leverage at dimnishing cap rates, IS the stuff of bubbles. And builders, both small and large tend to count their chickens before they proverbially hatch, which is a terrible thing to do when one is borrowing money to manufacture the metaphor itself, and such leverage has a time component wired against the speculator. Yet your points about supply and hardness are both valid and prescient, and separate the boys from the men.

What prompted the post is the rush of Private Equity no longer content to buy a 30,000sq ft building in Metuchen at an attractive cap rate, but rather the frenzy that money is everywhere, and increasingly in far greater supply than the assets themselves. My question is thus really meant to ponder the whether the general frenzy is a market bubble in the classic sense, or whether it is a more calculating statement about the political-economy that will refuse to countenance contractionary policy until its too late.

The interesting thing about some of these "bets" including the $20billion Blackstone vs. Zell mega-wager are the implicit but divergent assumptions necessary to make the action worthwhile. Notionally, one would think that cap rates would a fall further should recession come out way and US yield curve shift lower. BUT in Japan, property yields increased and capital values fell more or less continuously despite ZIRP and 2% JGB.

Commercial Real estate is one of the few asset classes where a new buyer can only make an asset sweat where the former owner was the most lazy and derelict owner (did I hear insurance company?) for which Sam Zell cannot be so accused, so the Blackstone puchase statement is a bigger statement about the future than on first glance. It seems to be saying that we will continue on our path for some while longer before we hit a brick wall, and so prime commercial bricks, (and mold might I say) do hold reasonable prospects for real capital preservation even at what appear to be low cap rates. The worst REITs on the other hand would be the long-term net-leased segment, which are not dissimilar from bonds with a long-dated call. Watch these for should rates spike, there will be an arbitrage opportunity to play these against fixed-income without the embedded call.

Anonymous said...

Re: Zell/Blackstone the jury is out since you do not know what he will do when he is shown the money.

But, his since his prop mgmt skills are probably not in question then the deal would point to some corp. structure, financing, taxation valuation discrepancy. Note he is still holding residential REITS, which have not been transacted.

Hmmm who might Blackstone be interested in exiting to? Are you getting your deal hat on? Ha Ha!

Cassandra said...

Anonymous - Thanks for that. Some big noise was made last year about Colony Capital reckoning US RE in general was overpriced and selling lots of props into the market. And it IS provided one suspends belief in what we know (I'll assume we learned the same things rote in skool) to be sustainable monetary expansion without becoming inflation (or deflation) roadkill. Cap Rates in the USA have always been the most attractive in OECD so part of this move in Comm RE is/was convergent and not divergent. But we are perhaps beyond that now UNLESS the staus quo can roll on for yet another year of disbelieving purgatory.

I tend to think that the economy is more levered to leverage so when tax rates rise, there will be cascades upon vacancy rates and rents. This puts me in the Roubini camp, but not until US fiscal policy tightens. The Fed will not be the dragon-slayer here.

(Also to one or another anonymous, thanks for Iwata's slides and the BoJ report)

Anonymous said...

Aye , there's the rub.

If you did the deal you would not need to worry either way.

Kind of like an MBS dealer who uses his bonus and subsidised mortgage to but the first "hyce" that catches his or her fancy.

By the way can you make heads or tails of those docs? There is a big tail in ne of the slides. Is that still going on?

Anonymous said...

(Moldbug again...)

Cassandra, your points are, as usual, well taken. I shouldn't dismiss animal spirits and other issues of mere psychological fashion too lightly - if you make it to the bottom of my megathread with JW over at RGE, you'll see me taking them quite seriously.

But I still hate the word "bubble" and here's why. It implies that there is some kind of delusional deviation from an absolute reality of objective prices. In fact, the deviation is not delusional and the reality is not objective.

The assumption that assets must have objectively correct prices for a given pattern of productive activity is the luminiferous ether of economics. The fundamental achievement of the Austrian School is the realization that it actually makes a lot more sense when you ditch the fixed reference frame.

People need a medium for transferring wealth to the long-term future. If you are a fisherman and you want to retire someday, keeping a pile of fish in your backyard is not an effective strategy for realizing your goal.

Therefore, assets that can serve as media of saving may tend to be (in terms of the luminiferous ether, or more properly relative to a world where everyone consumed everything they produced at once - for example, a world that was due to end in a week) "overvalued."

As a saver, it is obviously to your advantage to buy the same assets that everyone else overvalues. A classic path-dependent Nash equilibrium effect. There is absolutely no reason to suppose that all equally savable assets should attract equal levels of overvaluation due to saving.

What assets should experience this savings effect?

Some assets, like fish, have negative productivity, ie, high storage cost. Some assets, like gold, have fairly neutral productivity (low storage cost, low utility). Some assets, like commercial real estate, have positive productivity.

As a medium of saving, one might think that positive productivity would be the most important criterion. But if one were to think this, one would be wrong.

Scarcity, that is, inelasticity of supply, is the most important criterion. An asset like commercial real estate, which (I assume - I certainly lack anything like your knowledge on this subject!) is not mainly limited by scarcity, cannot sustain a price above its marginal production cost. (Nothing can. The point of an inherently scarce asset like gold is that the marginal production cost rises steeply with supply.)

When the market tries to use an asset whose scarcity is inadequate, be it tulips, Thai skyscrapers, or software companies, as a medium of saving, you get one very distinct kind of a bubble. Call it bubbleus dotcommus.

The real point is that none of this is a free-market effect. In a free-market world, exactly one good, which in most historical cases is gold or silver, winds up with all the overvaluation. This good is called "money." Everything else is priced in it, and valued in the usual objective way. In a free market, the way to save is to hold money, and that's all there is to it.

Now, if you know you will not need X amount of your money for Y length of time, you may be able to lend it to someone who will give you back X+d at the end of Y.

But this process of productive investment is entirely orthogonal to saving proper. So we'll ignore it for a moment, which we can do by assuming that all our savers are saving up for some event which may occur at any time. Therefore, they will simply hoard their gold or whatever, perhaps making little Gollum noises as they do so.

Anyway, when the state, as it did in the 20th century and to a lesser extent in the 19th, takes over money and reduces its effectiveness as a medium of saving by constantly diluting it to fund its various missionary endeavors, what happens is that a bunch of this monetary energy leaks out. And starts exploring other places where it can hang out for a while.

Austrians call this the "flight to real values." But which real values? Ah, there's the rub.

Unless (or until) it manages to make its way into something that can actually replace the broken-down wreck we call an international monetary system, like precious metals, this energy tends to spend a lot of time, and a lot of people's time, just sloshing around. It sloshes into one asset class, finds that scarcity is a problem, sloshes back out.

And sometimes it sloshes for no rational reason at all, so you get momentum, animal spirits, etc. Which of course every pundit in the world, as is their wont, will try to justify retroactively. Call this bubbleus hindsightius.

Why is gold more popular than platinum as a medium of saving, which is more popular than osmium? If there is a slosh from gold to platinum, or to anything else for that matter, people will talk about a "gold bubble" that "popped." Implying that it needed, for some mysterious ethereal reason, to restore balance to the universe, by so popping.

Which is all a bunch of nonsense. There is no pop here, only slosh. Market psychology may choose to amplify some slight fundamental bias, true, but it may also amplify some false rumor, or nothing at all.

In other words, the result of tampering with the money supply is basically an enormous waste of everyone's time. In my opinion, pretty much the entire financial industry puts most of its effort into managing this inflationary sloshing process. (The genius of Buffett, in my opinion, lies mostly in the fact that he has mostly managed to tune it out. In a hard-money world all investing is fundamental.)

So here is my explanation of why it was so hard for ZIRP to reverse declining property prices in Japan. If I am off base on this, in your opinion, I would be very interested in hearing it.

My view is that just because the cheap money came from Japan, didn't mean it had to go to Japan. Because of the moral hazard of exchange rate intervention, it could slosh anywhere, like into US stocks, and it did. Real estate in Japan was a scarce good, and scarcity is necessary for a sustainable medium of saving, but that doesn't make it sufficient. Nothing is sufficient.

But what is Sam Zell thinking? Is he thinking this? I have no information at all, but I greatly doubt it. Rhetorical abstractions derived from first principles are not exactly fashionable in today's economic and financial universe...

Anonymous said...

Bubbleus hindsightius?

November 2006
Management Should Always Be Aligned With Shareholders

Zell demands that management be aligned with shareholder interest. At its most basic, this means that management should own large positions in the company’s stock. Still, Zell cautions, “Management that is obsessed with stock price is worrisome. I want them to obsess about the business,” he says. Zell also recommends avoiding companies that have anti-takeover devices. “As someone responsible for a public company, I’m responsible for the public’s capital. If someone comes along and wants to buy it at the right price, why not?”

Think Long Term

If you are going to invest in a company, you should always be in it for the long haul. “When you own a company and the company is doing well, then keep going. You don’t make exponential profits by going short.”

June 2006
Clad in jeans and an open-necked shirt as he and his suit-and-tie clad peers lounged in soft chairs on a dais, Zell--a longtime and loud proponent of real estate securitization--proclaimed that privatization is "terrific," adding oddly that it validates everything the REIT industry has been working toward.

May 2006

6. Panel “The View from 10,000 Feet”, including Samuel Zell, Steven Roth, and
William Mack

Cassandra said...

moldy -

I concur with pretty much everything which is unusual because I so often enjoy picking a debate solely for the joust.

I agree that ZIRP did little for Japanese asset prices, and certainly far less than it did for US asset prices. But the ex-ante situation was perhaps more complex. I recall Osaka parimutuel & tired office-block landlord Keihanshin Real Estate (#8818) in 2003. It was trading at 10x post-tax stable earnings, moderate leverage, 0.6x book, a net div yield of 2% and more or less fully-let portfolio. Now o/n money was 0%. 10year money was 1.3%, and there was plenty supply of both. Yet, no one wanted a hard asset with a stable earnings yield 850bps > than JGBs. Sure there was "risk". Bush mightn't have cut taxes, and the Fed mightn't have poured petrol everywhere, and the Chinese mightn't have accumulated USD reserves in which case the recession wouldv'e been longer & deeper, JGBs wouldv'e gone to 1%, maybe Keihanshin's vacancy rates would have increased such that earnings yields declined 25% to 7.5%. Hardly a disaster. It was so cheap, one prescient attorney bought 4% of the Company, probably all the while wondering what everyone else could possibly be thinking. Now the big developers, on the other hand had some serious indigestion throughout most of ZIRP. And since they are developers, not REITs, they acquire land, plan, fund, construct from start to finish. Their hangover was severe, and it took a decade to clear the overhang, run off the rent consessions given to fill buildings completed at the height of the bubble. But in 2003, one such major was trading at YEN 1000 and at stated book value while making minisule "profits" @YEN 20/share, since new late 90s projects were still being constructed, and rents and capital values had been falling for a decade. Yet 4 years later they look like they are set to stably earn YEN200/share. There remains such "hard assets" with stable 10% earnings yields trading south of book even today, even with JGBs still yielding less than 2%.

People are currently obsessing about interim earnings, and hammering stuff that "misses" by a tad, though they are missing he really big picture that Japan remains a hot-bed of cheap high quality scarce assets for which one can still use crap USD to paper to acquire, AND which, in the absence of some borne-again US fiscal rectitiude will also yield a 30% or more intermediate-term currency again in addition to nominal increases in earnings and asset valuation. Better than mold? Hmmm........

Anonymous said...


If I had any money, I'd send it to you - I'm fascinated by your ability to discover cheap, banal assets deep in Japan. In particular it is the complete opposite of Silicon Valley, which always excites me. I am so done with this Web 2.0 thing.

There is a fascinating book called "The Triumph of Conservatism" that was written about 40 years ago by a young Marxist historian named Gabriel Kolko. (Who has since become an old Marxist historian named Gabriel Kolko.) It is a history of US business and finance in the Progressive Era. It takes the revisionist perspective that Progressivism (eg, TR) was the triumph not of enlightened reform, but of what we would now call crony capitalism.

Needless to say this is a perspective I find quite congenial.

But what reminded me of it was that Kolko's book is full of an old Wall Street linguistic trope. It seems that a century ago, when a company's market cap exceeded its book, the stock was referred to as "watered." I can't think of a better word for the effect described above, and perhaps one day it we'll have occasion to use it again...

(Moldbug, sighing with relief - his fingers are a little tired after his big tussle with Joseph Wang)

Anonymous said...


Re: derivatives risk management debate with JW here some research pointers to help validate and or invalidate:

Managing Derivative Risks
The Use and Abuse of Leverage
by Lillian Chew
Wiley 1996

Read this in the prior millenium but I recall it as cautionary and pretty good.

I think she identified leverage itself as risky, with "liquidity risk" and probability miscalculation as major sources of potential mispricing.

Anonymous said...


Cool, thanks...


Anonymous said...


RE: some of your points on Derivs then.

Of the risks Chew highlighted Leverage was being dealt, in part, with, top down as you surmised, Basel II.

Probability miscalculation and liquidity risk suggested better VAR models and internal and external supervision, but could not all be accounted for or calculated away.

LTCM as I have understood it was in good part a liquidity risk event. So as you point out the sitting around a table amounts to a removal of "the" risk associated with trading in LTCM risks. What in other words would have happened if they had not?

Do they now always sit around a table? How often should they sit. Did they sit around during Amaranth. And how important are derivs. to the "system".

Your debating points with JW in general appear quite valid.

Anonymous said...


Thanks again - I think intellectual cross-pollination between Austrian School theorizing and the messy reality is really important. I'll definitely check out Chew...